• Average wages grew in all economic sectors.
• Swedbank expects the growth of average gross wages to slow from 7.6% in 2016 to around 5% in 2017.

The growth of average gross wage accelerated to 7.6% in 2016. Net average wages grew rapidly too, by 7.5%, in real terms. The average full-time monthly gross wage was 1,146 euros in Estonia.

The rapid growth in the average wage is supported by a lack of suitable labour, a 10% increase in the minimum wage, a political agreement to raise the wages of teachers and healthcare workers, and strong domestic consumption that lifts the sales of enterprises selling their products and services in the domestic market. Irregular bonuses lifted the average wage growth by 0.4 percentage point last year.

In 2016, average gross wages increased in all sectors, although growth rates varied substantially. Average wages and employment grew rapidly in the real estate and ICT sectors. Average wages also grew rapidly in agriculture, tourism, healthcare, and education, where employment grew little or even declined. Wage growth was modest in mining, which was hurt by low energy prices at the beginning of the year.

Too fast growth of labour costs could be dangerous in the longer term, as it reduces companies’ ability to export and invest. A rapid growth of labour costs could hamper the manufacturing sector the most as it is directly exposed to foreign competition. However, recent surveys suggest that, at least currently, the sentiment among the manufacturing sector is rather optimistic and entrepreneurs’ assessment of their export competitiveness has improved. As export orders and output prices are expected to increase this year, the profitability of the business sector, including the manufacturing industry, should improve in 2017.

In 2017, the growth of average wage is supported by another rise in the minimum wage (+9%). The government also plans to raise the wages of teachers, social workers and policemen. The growth of the average wage in real terms is expected to slow from above 7% in 2016 to around 2% in 2017, as nominal growth of wages will be somewhat slower and prices will rise. This, in turn, would limit households’ consumption. The substantially slower growth of wage-earners’ purchasing power will be smoothed by an increase in social transfers to pensioners, low-wage earners and children.

In 2016, economic growth reached 1.6% in Estonia. Compared to 2015 it is a 0.2 percentage point increase, but nothing to be too proud of yet. Nominal growth of GDP accelerated from 2.5% in 2015 to 3.3% in 2016.

In the last quarter of 2016 Estonian economy grew 2.7%, which is the highest quarterly growth rate in two years and was above our expectations. Unfortunately the main contribution to this growth still came from private consumption whereas contribution of investments remained negative. Investments grew only in the second quarter and thereafter plummeted again. This means that 2016 was the fourth consecutive year in a row where investments decreased.

In 2016 ITC and domestic trade sectors had the largest positive and agriculture the largest negative contribution to GDP growth. Negative contribution from agricultural sector comes from a 30% decline in value-added as crop yields compared to averages were better in 2015 and worse in 2016. In the last quarter of 2016 economic growth was relatively broad based with only a few sectors that contributed negatively.

Households’ investments into dwellings grew rapidly in 2016 whereas investments of enterprises and general government were in a decline. The main positive contribution to enterprises investments came from transportation equipment whereas investments into buildings and machinery are still lagging. In the last quarter of 2016 enterprises’ investment into machinery has somewhat improved, but growth remains negative compared to last quarter of 2015.

On a positive note export growth in 2016 was 3.6% compared to -0.6% decline in 2015. The contribution of net export to growth remained negative in total, but in the last two quarters of 2016 export growth has been stronger than import. This implies that Estonian exporters are gaining strength, although export growth in the last quarter of 2016 somewhat decelerated.

Private consumption has remained the engine of growth due to very strong wage growth. This is about to change as this year prices will increase and real net wage growth decelerates rapidly. In 2017 we expect smaller contribution to growth from private consumption and larger contribution from investments and government expenditure. Contribution of private consumption to growth will somewhat increase in 2018 when non-taxable income threshold is raised. We expect the economy to grow 2.2% this year and 2.8% in 2017.

In 2016, non-financial sector profits decreased 10% in Estonia. Profits decreased third year in a row.

Robust wage growth has contributed to the decrease in corporations’ profits

The major share of the decrease in profits came from manufacturing, real estate activities and transport sector, while the increase in profits in wholesale trade was by far the strongest among others.

Although the growth of labour costs has decelerated, their share in corporations’ sector turnover has risen to the highest level of the last 15 years (excluding 2009 with recession). At the same time, profitability (the share of profits in turnover) has shrunk to the lowest level of the last 15 years (again, excluding 2009). Thus, robust wage growth and increased labour costs have contributed substantially to the reduction of corporations’ profits. In addition to the higher labour costs, decreased selling prices have been behind the weaker profits, as well.

After two years of decline, corporations’ sector turnover recovered and reached 2% growth in 2016, contributed primarily stronger foreign demand and selling prices. Exports of goods and services increased 4% in nominal terms and producer and export prices started to increase at the end of last year.

Corporations’ investments decreased fourth year in a row

Despite the corporations’ improving confidence, accelerated increase of their credit portfolio and gradual increase of capacity utilization, non-financial corporations’ investments decreased already fourth year in a row (i.e – 12% in 2016). Approximately half of the contraction of investments came from the energy sector, whereas investments in transport sector increased the most (60%). The share of investments has dropped to the lowest level. Less investments together with the decrease in labour force and weaker productivity growth or even decrease (corporations’ sector productivity has decreased two years in a row) result in less potential economic growth.

Despite the decrease in profits, corporations’ financial situation and their solvency is good

Although the growth of corporations’ sector credit portfolio has accelerated, decrease in investments and less lending from abroad has restrained the growth of corporations’ debt. Despite the decrease in profits less investments contribute to the increase in liquid assets. Low interest rates contribute to less interest payments and thereby have positive impact on corporations’ solvency. However, the expected increase in investments and receding short-term loans, corporations’ debt liabilities are expected to increase in the coming years. Accumulation of profits has increased corporations’ equity (increase of equity has decelerated) and this does not considerably limit payment of dividends.

Wage growth is expected to exceed productivity growth

The deceleration of labour costs, increasing selling prices and stronger foreign demand are expected to improve corporations’ sector profits. At the same time, expected recovery of investments will work against it. Although the growth of labour costs has decelerated, shortage of qualified labour force contribute to the robust wage growth at least in the coming few years. Wage growth is expected to exceed productivity growth and thereby possibly impairing corporations’ competitiveness.